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Minimum performance levels in your contract - are they binding or not?
BlogCorporate

A recent Court of Appeal decision has found that a table of minimum acceptable performance levels in a services contract were contractually binding. The case is of interest to those who negotiate commercial agreements. It illustrates the need for clear, careful and co-ordinated drafting of service levels and the consequences of failure to meet them.

Background

Most sophisticated commercial contracts for services will contain schedules and/ or appendices full of detailed service levels (SLs) and they will often set out key performance indicators (KPIs) which are used to measure the performance and efficiency of the party providing the services.

These are key components of a services contract because failure to achieve SLs or KPIs can often result in a payment deduction or other financial sanction against the provider or, in the case of severe or repeated failures, termination of the contact altogether.

This is indeed what happened in the recent Court of Appeal case of Sutton Housing Partnership Ltd v Rydon Maintenance Ltd {Click here}.

Facts

Sutton engaged Rydon to carry out repairs and maintenance to Sutton’s housing stock. The 5 year contract was based on the National Housing Federation’s standard form contract and it contained a table of KPIs which set out the benchmark for measuring Rydon’s performance.

The contract also referred to a set of tables containing ‘minimum acceptable performance levels’ (MAPs). These set out the absolute minimum level of performance that would be acceptable to Sutton over the term of the contract, and gave Sutton a right of early termination should these MAPs not be achieved. In addition, the payment of certain bonuses to Rydon was linked to the MAPs.

The table of KPIs did not itself expressly set out what the relevant MAP was for each individual KPI. The only place where the MAPs were explicitly laid out was in a set of three calculations which were termed as “examples” to show how these penalties and/or bonuses would be calculated.

The dispute

Sutton served a notice asserting that Rydon had failed to achieve certain MAPs, and sought to terminate the contract on this basis.

Rydon argued that, because the contract did not clearly set out the MAPs for each KPI, it could not be terminated on the grounds of failing to achieve any particular MAPs.

Sutton argued that the examples in the contract showed that, in each case, the MAP was 3% below the target KPI. The MAP for each KPI could therefore be deduced arithmetically.

The case ended up with the Court of Appeal. It had to decide whether the MAPs were contractually binding or merely illustrative. If they were simply illustrative, then the termination was invalid.

The decision

The Court of Appeal found in favour of Sutton.

It discussed the role of commercial commonsense in the interpretation of contracts. The court concluded that any reasonable person standing in the shoes of the parties would have intended the contract to contain MAPs because, without them the contractor would not receive the anticipated performance-related bonuses and Sutton would not be able to enforce its right to terminate for a failure to achieve MAP levels.

The court also held that the three ‘examples’ made it abundantly clear that in every instance, the MAP was 3% lower than the associated target KPI figure. Therefore the MAPs used in the ‘examples’ were actual MAPs as opposed to hypothetical ones by way of illustration.

The court pointed out that the contract was

“a commercial one, made between a local authority and a building contractor. Self-evidently, Rydon intended to receive all the bonuses which were due to it under the incentivisation scheme. That was only possible if the contract specified MAPs. Also self-evidently, Sutton intended to retain their valuable power to terminate for poor service … That was only feasible if the contract contained MAPs.”

Whilst it feels that the decision of the Court of Appeal is a sensible one in this instance, this case nonetheless comes with a number of lessons that we can take away from it:

Do not assume that any missing or unclear terms in a loosely drafted contract will be rectified by a court applying a liberal does of commercial commonsense. The threshold is high and, in the present case, the implication was successful because such contractual construction was “the only rational interpretation of the curious contractual provisions into which the parties have entered”.

If you want to avoid lengthy and expensive litigation, ensure that your contracts are drafted clearly to reflect what the parties intend- even if it seems like stating the obvious!

Often, SLs and KPI schedules are put together by the finance/ operations directors of one of the contracting companies, and provided to the company lawyer to be cut and pasted into the contact. This is not good enough. All parties- clients and advisers- need a clear understanding of the trigger points for performance related payments and punishments, and to ensure that everything in the ‘back end’ of the contract flows through to the operative parts of the ‘front end’.

Compare jurisdictions: Litigation: Enforcement of Foreign Judgments

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